Final Regs on Tangible Property Deduction/Capitalization Set

The age-old issue of whether to deduct or capitalize just got a bit more clear.

While it’s been a long time coming, the IRS has issued new rules under Code Sections 162(a) and 263(a) on when to deduct or capitalize amounts paid to acquire, produce or improve tangible property.

“These will affect all taxpayers across all industries,” said David Auclair, national managing principal in Grant Thornton’s Washington National Tax Office.

“Historically, proposed regs were issued in 2006,” he noted. “Since then, we’ve seen another set of proposed regs, a set of temporary and proposed regs, and now final and re-proposed regs.”

“The final regs provide rules for amounts paid to acquire, produce or improve tangible property. They apply to any taxpayer that has tangible property,” he said. “However, there is a small taxpayer exception: If a taxpayer with average annual gross receipts of $10 million or less has a building with an unadjusted basis of $1 million or less, they don’t have to apply these rules to that building.”

“The re-proposed regs deal with rules for dispositions of depreciable property. These are important because they have rules for partial dispositions of depreciable property,” he said. “For example, if you have a roof on a building and you remove the entire roof -- rafters, joists and everything -- and replace it with a new roof, as you read through the rules, you would have to capitalize that major components. So if you remove the old roof and you couldn’t recover the remaining basis, you would be depreciating two roofs: the new one, and the old one which was probably on the building when you purchased it. These rules allow that when a capital cost is new, you can recover the remaining basis in the old roof, and would give a loss deduction for that amount. The concept was first introduced in the temporary regs, and now the re-proposed regs. The difference is that the rules to take that partial disposition are much simpler in the re-proposed regs.”

The applicability of the new rules can be challenging, however.

“For the 2012 and 2013 tax years, taxpayers can apply the final regs, the re-proposed regs, the temporary regs or any combination thereof,” said Auclair. “But beginning in 2014, the re-proposed regs will become final. Everyone must apply the final regulations in 2014.”

The final regs contain a de minimis safe harbor for taxpayers to deduct either an invoice or item of $5,000 or less. “The taxpayer needs to have applicable financial statements to do so,” said Auclair. “For smaller taxpayers that don’t have these applicable financial statements, the safe harbor amount is $500 rather than $5,000. So if you bought a computer for $2,000, and you had a policy for the books that expenses amounts below $5,000, you could expense it. Most businesses have such a rule, and this will provide some certainty to them.”

Except for the de minimis rule, the final regs are in large part similar to the temporary regs, Auclair noted, though there are some significant differences. “The challenge for taxpayers is to get an understanding of these rules, and the sooner they do this the better. They need time to digest them to take advantage of the opportunities, and they have a quickly approaching effective date of Jan. 1, 2014.”

Note: No material from Grant Thornton in this article, or in the comments below, should be considered tax advice; it is strictly for educational purposes.

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